The Distorted Numbers of Company Founders

allen

5 years ago

This article came across my Twitter feed today. It talks about how as a founder, one of the nice side benefits of success is being able to reward those loyal and faithful employees with equity that turns into real cash. It’s a happy story for everybody involved: employees win, executives and high-level managers and founders win, and investors definitely win.

Now, the author of the piece isn’t exactly known as a humble writer, so it’s unfair to use just this piece alone to paint broad strokes on the mentality of founders at large. What struck me wasn’t the slight tinge of condescension in a founder – who has undoubtedly made millions or tens of millions with the fame match, calling his employees “rich” – but the actual numbers themselves. Even if the personality is atypical, the percentages and values are in line with what startup employees should be expecting.

With standard liquidity preferences, investors get dibs on their money first, so there will likely not be the full purchase amount to share among the common shareholders (e.g., the employees).

Whatever percentage of the company an employee was offered when they joined will likely have been diluted through multiple rounds of investments[1].

The percentage of the company for a non-founder and a non-investor will be small and diminishingly so over time. Joel’s answer on this puts real numbers on the table, but the share of equity falls off a cliff after worker #10 or so at a startup, and even then the first employees are basically doing the same work as the founders, just for a whole lot less.

On the plus side, if the company is making headway there will usually be refresher grants, but in every case I’ve seen they’re only a fraction of the initial grant, and not meant to provide the same amount of reward or enticement as a new hire equity package. It’s a “here’s something small so you have some reason to stay after all your options have vested”.

So in the article’s scenario of a $100 million exit[2], key employee #5 (who just eeked into the seed round pool) who was granted a generous 1% of the company would be left with something <$1 million, and maybe three-quarters of that amount after taxes. Over four years, this comes out to maybe an extra $200k/year on top of what’s likely a below-market salary with below-market benefits. This supposedly lottery-ticket, life-changing amount is akin to a nice bonus at a bigger firm, with a much lower chance of realization.

Of course, for the founder, any single- or double-digit percentage stake of a nine-figure exit is indeed life-altering. It nets them enough money for at least a few years of fun, stupid ideas, and most importantly – that kind of an exit creates a halo of entrepreneurship success that enables articles like the above to be written with a straight face. There have been studies that link a lack of compassion to wealth; I wonder whether the attitudes of the wannabe-wealthy are all that much different.

Okay, so the salary math for startups isn’t that attractive. Yet, I keep on going back to them, and having worked for three startups (my current one is doing alright), I was certainly naive at the start but certainly ought to have figured out the rules of the game by now. There are good reasons for joining startups that go beyond the stereotypical ping pong tables and video games[3]; I’ll gather my thoughts and save them for a future post.

Footnotes (↑ returns to text)

With the understanding that the main determinant of value for private equity its percentage of the whole thing.↑